A worker inspects damage to a burnt oil processing facility in the petroleum centre of Heglig, in the disputed South Kordofan state in Sudan. Photograph: Ashraf Shazly/AFP/Getty Images

The Greater Nile pipeline is the only way to get oil to market from South Sudan. It is a lifeline: 98% of the country's revenue is from oil but, since January, no South Sudanese oil has flowed through it.

The pipe, 1,600km (994 miles) long, starts in the Unity and Heglig oil fields – the first of which lies in Unity province, South Sudan, the second in the disputed territory of South Kordofan. It runs north, into Sudan, swerves up past Khartoum, then follows the river Nile towards Egypt for a few hundred kilometres, before cutting off and running east to where it meets the Red Sea at Port Sudan.

The Unity oil field is the largest and most important oil reserve in either of the Sudans. Since January, however, production at Unity, as well as in all of South Sudan's other oil fields, has been halted by the government. This extreme measure was in response to the north's attempt to strong-arm the south into paying an extraordinary $36 (£23) per barrel to transit oil through the Greater Nile pipeline – considerably more than 10 times the international average.

In January, after talks about an interim oil deal broke down, the north also seized $800m-worth of South Sudanese oil and redirected it to its own refineries. Sudanese president Omar Hassan al-Bashir is not so much taking a negotiating position as making a ransom demand.

The symbolism of the price is even more important than the theft of the oil. The $2.6bn that the exorbitant pipeline fees were projected to cost the south this year is almost exactly what the north would have earned if South Sudan had not gained independence, when the two regions had an uneasy 50/50 revenue-sharing deal.

But now South Sudan controls more than 85% of the oilfields and anything that sounds too much like a return to how things were before independence is going to be unacceptable to the south. For the north to attempt to manipulate the situation by extortion is downright inflammatory.

South Sudan is proud of its new independence. Its president, Salva Kiir Mayardit, a soldier by trade whose trademark cowboy hat was a gift from George Bush, is a stubborn man. If Bashir thinks the south is bluffing and believes he can manipulate and bully Salva Kiir into returning to the old 50/50 deal, he has badly miscalculated.

He should have realised this last month, when South Sudanese troops captured the Heglig oilfield – which represents only a little less than half of all of the north's remaining oil. Production by the north has now restarted there, though it is not known how much damage was wrought before the oilfield was returned.

Bashir, whose position in the north is already weak, has missed any opportunity to make a deal. He can't afford to go fully to war again with the south whose army, the Sudan people's liberation army (SPLA), are an efficient fighting force – though he is clearly more than willing to harry South Sudan around its borders. The two countries are not yet fully at war, and the south's return of the Heglig oil field, after huge pressure from international donors, is a sign that it also has little appetite for another full-blown conflict.

In the meantime, South Sudan is looking east for help during the shutdown. It hopes that a pipeline can be constructed from the ocean ports of Kenya to South Sudan via Uganda – meaning Juba's oil could eventually make a straight shot to the south-east, the shortest route to the sea.

Kenya and Uganda, unsurprisingly, are smiling on the project: Khartoum's loss will be their gain. But this is not a part of the world where large-scale construction is easy to execute, and South Sudan's pipe dream risks remaining just that. There are a thousand factors which could set back such a project – bandits, weather, political scrapping over cost, and so on. The port of Lamu in Kenya, the planned sea connection for the pipe, hasn't even been built yet.

South Sudan has reached out to China for emergency loans and assistance building the Kenya pipeline, but Chinese premier Hu Jintao has refused to offer support in construction, though China has offered bank loans and emergency aid to South Sudan. China finds itself in a tricky position: it is the biggest investor in oil in both Sudan and South Sudan.

In turning off the oil taps, South Sudan, already one of the world's least developed economies, is risking catastrophe. Oil accounts for the vast majority of the country's revenue and since the oilfields have been shut the value of the South Sudanese pound has plummeted. Without it and with the rainy season fast approaching it seems likely that the mood at home will become mutinous and funds earmarked by donor countries for long-term development are already being redirected to emergency humanitarian aid instead.

South Sudan's foreign minister, Nhial Deng Nhial, was asked on the BBC's Hardtalk programme if his country could survive on a meagre 2% of its previous revenue. "There will have to be," he answered grimly, "austerity measures".

But the south has calculated that the shutdown is still the better option than paying the north a ransom to transit the oil – money that might well be revisited on the south anyway in the form of bombs and bullets.